Chapter 6-Inventory Management ..........

supply chain management

1. Chapter 6 Inventory Management

2. Inventory Management The objective of inventory management is to strike a balance between inventory investment and customer service

3. Importance of Inventory One of the most expensive assets of many companies representing as much as 50% of total invested capital Less inventory lowers costs but increases chances of running out More inventory raises costs but always keeps customers happy

4. Functions of Inventory To provide a selection of goods for anticipated demand and to separate the firm from fluctuations in demand To decouple or separate various parts of the production process To take advantage of quantity discounts To hedge against inflation

5. Types of Inventory Raw material Purchased but not processed Work-in-process (WIP) Undergone some change but not completed A function of cycle time for a product Maintenance/repair/operating (MRO) Necessary to keep machinery and processes productive Finished goods Completed product awaiting shipment

6. The Material Flow Cycle

7. ABC Analysis Divides inventory into three classes based on annual dollar volume Class A - high annual dollar volume Class B - medium annual dollar volume Class C - low annual dollar volume Used to establish policies that focus on the few critical parts and not the many trivial ones

8. ABC Analysis A Items B Items | | | | | | | | | | 10 20 30 40 50 60 70 80 90 100 Percentage of annual dollar usage 80 – 70 – 60 – 50 – 40 – 30 – 20 – 10 – 0 – Percentage of inventory items Figure 12.2 C Items

9. ABC Analysis Other criteria than annual dollar volume may be used High shortage or holding cost Anticipated engineering changes Delivery problems Quality problems Policies employed may include More emphasis on supplier development for A items Tighter physical inventory control for A items More care in forecasting A items

10. Record Accuracy Accurate records are a critical ingredient in production and inventory systems Periodic systems require regular checks of inventory Two-bin system Perpetual inventory tracks receipts and subtractions on a continuing basis May be semi-automated Incoming and outgoing record keeping must be accurate Stockrooms should be secure Necessary to make precise decisions about ordering, scheduling, and shipping

11. Cycle Counting Items are counted and records updated on a periodic basis Often used with ABC analysis Has several advantages Eliminates shutdowns and interruptions Eliminates annual inventory adjustment Trained personnel audit inventory accuracy Allows causes of errors to be identified and corrected Maintains accurate inventory records

12. Cycle Counting Example 5,000 items in inventory, 500 A items, 1,750 B items, 2,750 C items Policy is to count A items every month (20 working days), B items every quarter (60 days), and C items every six months (120 days) ITEM CLASS QUANTITY CYCLE COUNTING POLICY NUMBER OF ITEMS COUNTED PER DAY A 500 Each month 500/20 = 25 /day B 1,750 Each quarter 1,750/60 = 29 /day C 2,750 Every 6 months 2,750/120 = 23 /day 77/day

13. Control of Service Inventories Can be a critical component of profitability Losses may come from shrinkage or pilferage Applicable techniques include Good personnel selection, training, and discipline Tight control of incoming shipments Effective control of all goods leaving facility

14. Shrinkage Shrinkage Retail inventory that is unaccounted for between receipt and sale Retail Inventory Shrinkage This refers to the difference between the recorded inventory ad actual physical inventory in a retail store. Causes Theft, damage, spoilage or administrative errors Measures to minimize shrinkage Security measures, inventory management and loss prevention programs

15. Pilferage Pilferage Pilferage refers to the act of stealing small quantities of goods or materials, often from an employer, organization or commercial establishment. Employees, contractors or individuals with insider knowledge may be more likely to engage in pilferage. Pilferage can be a pattern of repeated, small scale thefts, rather than a single, isolated incident.

16. Inventory Models Independent demand - the demand for item is independent of the demand for any other item in inventory Dependent demand - the demand for item is dependent upon the demand for some other item in the inventory Holding costs - the costs of holding or “ carrying ” inventory over time Ordering cost - the costs of placing an order and receiving goods Setup cost - cost to prepare a machine or process for manufacturing an order May be highly correlated with setup time

17. Holding Costs TABLE 12.1 Determining Inventory Holding Costs CATEGORY COST (AND RANGE) AS A PERCENT OF INVENTORY VALUE Housing costs (building rent or depreciation, operating costs, taxes, insurance) 6% (3 - 10%) Material handling costs (equipment lease or depreciation, power, operating cost) 3% (1 - 3.5%) Labor cost (receiving, warehousing, security) 3% (3 - 5%) Investment costs (borrowing costs, taxes, and insurance on inventory) 11% (6 - 24%) Pilferage, space, and obsolescence (much higher in industries undergoing rapid change like tablets and smart phones) 3% (2 - 5%) Overall carrying cost 26%

18. Inventory Models for Independent Demand Need to determine when and how much to order Basic economic order quantity (EOQ) model Production order quantity model Quantity discount model

19. Basic EOQ Model Demand is known, constant, and independent Lead time is known and constant Receipt of inventory is instantaneous and complete Quantity discounts are not possible Only variable costs are setup (or ordering) and holding Stockouts can be completely avoided Important Assumptions

20. Inventory Usage Over Time Figure 12.3 Order quantity = Q (maximum inventory level) Usage rate Average inventory on hand Q 2 Minimum inventory Inventory level Time Total order received

21. Minimizing Costs By minimizing the sum of setup (or ordering) and holding costs, total costs are minimized Optimal order size Q * will minimize total cost A reduction in either cost reduces the total cost Optimal order quantity occurs when holding cost and setup cost are equal

22. Robust Model The EOQ model is robust It works even if all parameters and assumptions are not met The total cost curve is relatively flat in the area of the EOQ

23. Lead Time Lead Time: In purchasing systems, the time between placing an order and receiving it In production systems, the wait, move, queue, set up and run times for each component produced

24. Re-order Points The inventory level (point) at which action is take to replenish the stocked item. The reorder point is given as: ROP= Demand per day x Lead time for a new order in days ROP= d x L The equation for ROP assumes that demand during lead time and lead time itself are constant, otherwise extra stock should be added. The ROP with safety stock then becomes ROP=Expected demand during lead time x safety stock

25. Risk Pooling It is a strategy used in supply chain management to reduce the risk of stock outs and overstocking by aggregating demand from multiple locations or products. By pooling the risk, the overall variability in demand is reduced, allowing for better forecasting and inventory management.

26. Types of Risk Pooling Location Pooling Aggregating demand from multiple locations to reduce the variability in demand Product Pooling Aggregating demand from multiple products to reduce the variability in demand

27. Risk Pooling: Examples Amazon's Fulfillment by Amazon (FBA) program : Amazon pools the inventory of multiple sellers in its warehouses, reducing the risk of stockouts and overstocking Walmart's Distribution Centers: Walmart aggregates the demand from multiple stores and pools the inventory in its distribution centers, reducing the risk of stockouts and overstocking Dell's Build-to-Order Production: Dell pools the demand from multiple customers and produces computers to order, reducing the risk of overstocking and inventory obsolescence.

28. Extra Stock/Safety Stock Extra Stock/Safety Stock Extra Stock to allow for uneven demand: A buffer It refers to the additional inventory that a company keeps in hand to mitigate the risk of stock outs in supply chain.

29. Purpose of Safety Stock The main purpose of safety stock are: Demand Uncertainty: To account for fluctuations in customer demand that may be higher than forecasted. Lead Time Variability: To buffer against delays in the supply of raw materials, components or finished gods from suppliers. Unexpected Events: To provide a buffer against unforeseen events like natural disasters, labor strikes or equipment breakdowns that could disrupt the normal flow of inventory

30. Production Order Quantity Model Used when inventory builds up over a period of time after an order is placed Used when units are produced and sold simultaneously Figure 12.6

31. Quantity Discount Models Reduced prices are often available when larger quantities are purchased Trade-off is between reduced product cost and increased holding cost TABLE 12.2 A Quantity Discount Schedule PRICE RANGE QUANTITY ORDERED PRICE PER UNIT P Initial price 0 to 119 $ 100 Discount price 1 200 to 1,499 $ 98 Discount price 2 1,500 and over $ 96 Total annual cost = Setup cost + Holding cost + Product cost

32. Inventory Metrics Inventory metrics are used to measure and evaluate the efficiency and effectiveness of inventory management.

33. Inventory Metrics Inventory metrics include : 1 . Inventory Turnover: The number of times inventory is sold and replaced within a given period . 2 . Inventory Days Supply: The number of days it would take to sell through the current inventory . 3. Fill Rate: The percentage of customer orders that are fulfilled from existing inventory . 4 . Stockout Rate: The percentage of customer orders that cannot be fulfilled due to inventory unavailability . 5 . Overstock Rate: The percentage of inventory that is excess or surplus

34. Inventory Metrics 6 . Inventory Accuracy: The percentage of inventory records that match actual physical inventory. 7. Lead Time: The time it takes to replenish inventory. 8. Inventory Carrying Cost: The cost of holding and storing inventory, including storage, handling, and maintenance costs 9 . Inventory Shrinkage: The loss of inventory due to theft, damage, or administrative errors . 10 . Gross Margin Return on Investment (GMROI): A measure of the profitability of inventory, calculated by dividing gross margin by the average inventory investment. These metrics help businesses optimize their inventory levels, reduce waste and excess, and improve customer satisfaction.